[Federal Register Volume 63, Number 166 (Thursday, August 27, 1998)]
[Rules and Regulations]
[Pages 45699-45711]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-22933]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 1


Orders Eligible for Post-execution Allocation

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'') has 
amended Commission Regulation 1.35(a-1) to allow bunched orders for 
eligible customers to be placed on a contract market without specific 
customer account identification either at the time of order placement 
or at the time of report of execution. Specifically, the amendment 
exempts from the customer account identification requirements of 
Regulation 1.35(a-1)(1), (2)(i), and (4) bunched futures and/or option 
orders placed by eligible account managers on behalf of eligible 
customer accounts. The amendment permits bunched orders entered on 
behalf of these accounts to be allocated no later than the end of the 
day on which the order is executed.

EFFECTIVE DATE: October 26, 1998.

FOR FURTHER INFORMATION CONTACT: I. Michael Greenberger, Director; Alan 
L. Seifert, Deputy Director; John C. Lawton, Associate Director; Duane 
C. Andersen, Special Counsel, Division of Trading and Markets, 
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st 
Street, N.W., Washington, D.C. 20581. Telephone: (202) 418-5430.

SUPPLEMENTARY INFORMATION: 

Table of Contents

I. Background
    A. Current Regulatory Requirements
B. Prior Regulatory Action
    C. Proposed Amendment to Regulation 1.35(a-1)
II. Amendment to Commission Regulation 1.35(a-1)
    A. Eligible Orders
    1. Proposed Regulation 1.35(a-1)
    2. Comments Received
    3. Final Regulation 1.35(a-1)(5)
    B. Eligible Account Managers
    1. Proposed Regulation 1.35(a-1)(5)(ii)
    2. Comments Received
    3. Final Regulation 1.35(a-1)(5)(i)
    C. Eligible Customers
    1. Proposed Regulation 1.35(a-1)(5)(iii)
    (a). 1.35(a-1)(iii)(A)--Types of Customers
    (b). 1.35(a-1)(5)(iii)(B)--Proprietary Interest
    2. Comments Received
    (a). 1.35(a-1)(5)(iii)(A)--Types of Customers
    (b). 1.35(a-1)(iii)(B)--Proprietary Interest
    3. Final Regulation 1.35(a-1)(5)(iii)
    D. Disclosure--Final Regulation 1.35(a-1)(5)(iii)
    E. Account Certification
    1. Proposed Regulation 1.35(a-1)(5)(iv)
    2. Comments Received
    3. Final Regulation 1.35(a-1)(5)(iv)
    F. Allocation
    1. Proposed Regulation 1.35(a-1)(5)(v)
    2. Comments Received
    3. Final Regulation 1.35(a-1)(5)(v)
    G. Recordkeeping
    1. Proposed Regulation 1.35(a-1)(5)(vi)
    2. Comments Received
    3. Final Regulation 1.35(a-1)(5)(vi)
    H. Contract Market Rule Enforcement Programs
    1. Proposed Regulation 1.35(a-1)(5)(vii)
    2. Comments Received
    3. Final Regulation 1.35(a-1)(5)(vii)
III. Conclusion
IV. Other Matters
    A. Regulatory Flexibility Act
    B. Paperwork Reduction Act

I. Background

A. Current Regulatory Requirements

    The Commission's Regulations 1.35(a-1) recordkeeping requirements, 
in effect since March 24, 1972, specify that customer orders must be 
recorded promptly and include customer account identification at the 
time of order entry and the time of report of execution. Specifically, 
Commission Regulation 1.35(a-1)(1) requires that each futures 
commission merchant (``FCM'') and each introducing broker (``IB'') 
receiving a customer's order immediately prepare a written record of 
that order, which includes an account identifier for that customer. 
Regulation 1.35(a-1)(2)(i) requires that each member of a contract 
market who receives a customer's order on the floor of a contract 
market that is not in writing immediately prepare a written record of 
that order, including the appropriate customer account identification. 
Regulation 1.35(a-1)(4) requires, among other things, that each member 
of a contract market reporting the execution of a customer's order from 
the floor of a contract market include the account identification on a 
written record of that order.

B. Prior Regulatory Action

    On June 8, 1992, the Commission published for public comment a 
proposed amendment to Chicago Mercantile Exchange (``CME'') Rule 536 
(``1992 proposal'').\1\ The amendment would have exempted from CME 
customer account designation requirements certain orders placed by a 
limited group of investment managers on behalf of specified 
institutional accounts. The orders would have been required to be 
allocated prior to the end of the day. The Commission received 31 
comments, which were addressed in the Commission's subsequent proposed 
amendment to Regulation 1.35, discussed below.\2\
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    \1\ 57 FR 24251 (June 8, 1992).
    \2\ Twenty-six of the comments evidenced support for the 
proposed rule amendment, four were opposed to the amendment, and one 
recommended caution.
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    On May 3, 1993, the Commission published for public comment 
proposed amendments to Regulation 1.35(a-1) designed to accommodate the 
CME proposal (``1993 proposal'') \3\ and the related comments thereon. 
In addition to amending Regulations 1.35(a-1)(1), (2), and (4), the 
Commission proposed to add paragraphs 1.35(a-1) (5) and (6). Paragraph 
(5), which addressed the placement of bunched orders and the use of 
predetermined allocation formulas, was superseded by the Commission's 
Notice of Interpretation and Approval Order, published May 9, 1997.\4\ 
This Order approved the National Futures Association (``NFA'') 
Interpretative Notice to NFA Compliance Rule 2-10 Relating to the 
Allocation of Block Orders for Multiple Accounts which established 
standards and procedures for allocating orders pursuant to 
predetermined allocation schemes.\5\
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    \3\ ``Account Identification for Orders Submitted on Behalf of 
Multiple Customer Accounts,'' 58 FR 26274 (May 3, 1993).
    \4\ 62 FR 25470 (May 9, 1997).
    \5\ The Order also provided additional Commission guidance 
regarding bunched orders and allocation procedures. The guidance 
provided therein has since been published as Appendix C to Part One 
of the Commission's regulations.
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    Paragraph (6) was the Commission's followup to CME's 1992 proposal. 
Paragraph (6) proposed allowing the placement of certain bunched 
``intermarket'' orders without customer account identification and 
permitting the allocation of those orders at the end of the day. The 
Commission stated that the proposed regulation would encourage and 
facilitate institutional participation in the futures markets subject 
to customer protection requirements that were consistent with the 
sophistication of the institutional

[[Page 45700]]

customers. The Commission received 34 comments. Most commenters found 
the proposed rule burdensome and too restrictive to be of value. In 
particular, many commenters objected (1) to the proposed requirement 
for an intermarket trading strategy involving securities and (2) to the 
detail of recordkeeping and certification requirements.
    Following review of the comments on the 1993 proposal, the 
Commission staff continued to consider alternative means to provide 
relief from the account identification requirements without increasing 
the potential for preferential allocation.

C. Proposed Amendment to Regulation 1.35(a-1)

    On January 7, 1998, the Commission published the reproposed 
amendments to Regulation 1.35(a-1) for public comment (``1998 
proposal'') as a response to the concerns raised in the 1993 
proposal.\6\ In addition to amending Regulation 1.35(a-1)(1), (2), and 
(4), the Commission proposed to add paragraph 1.35(a-1)(5). Under the 
1998 proposal, a specific customer's account identifier need not be 
recorded at the time an eligible bunched order (``eligible order'') is 
placed or upon report of execution, and the order could be allocated by 
the end of the day on which it was executed, provided that certain 
requirements were met. The order must be handled in accordance with 
contract market rules submitted to the Commission pursuant to Section 
5a(a)(12)(A) of the Act and Regulation 1.41.
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    \6\ ``Account Identification for Eligible Bunched Orders,'' 63 
FR 695 (January 7, 1998).
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    The Commission received 13 comments in response to the 1998 
proposal. Commenters included four associations,\7\ six exchanges,\8\ 
and four firms registered with the Commission as FCMs.\9\ Although most 
comments found that the 1998 proposal eliminated many of the practical 
difficulties of the 1993 proposal, they also contended that unnecessary 
restrictions remained. Among the 1998 proposal's provisions found to be 
overly restrictive were the portfolio requirement,\10\ the customer 
consent requirement, the limitation on proprietary interest, the 
exclusion of foreign advisers as eligible account managers, and the 
exclusion of natural persons as eligible customers.
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    \7\ NFA, Managed Funds Association (``MFA''), Investment Company 
Institute (``ICI''), and the Association of the Bar of the City of 
New York (``NY Bar''). The NFA comment was derived after discussions 
among members of a subcommittee of NFA's Special Committee for the 
Review of a Multi-Tiered Regulatory Approach.
    \8\ Chicago Mercantile Exchange, Chicago Board of Trade 
(``CBT''), New York Mercantile Exchange (including Commodity 
Exchange, Inc.) (``NYMEX''), Coffee, Sugar & Cocoa Exchange, Inc. 
(``CSCE''), and New York Cotton Exchange (``NYCE'').
    \9\ Goldman, Sachs & Co. (``Goldman''), E D & F Man 
International (``Man'') FIMAT Futures USA, and Lehman Brothers, Inc. 
The latter two firms are not individually further referenced because 
their comment letters were written to support the NFA comment.
    \10\ The proposal required that eligible orders must be placed 
as part of the account manager's management of a portfolio also 
containing instruments which are either exempt from regulation 
pursuant to the Commission's regulations or excluded from Commission 
regulation under the Act. This was intended to permit account 
managers handling portfolios involving futures and other instruments 
to allocate as to all components of the portfolio at the end of the 
day.
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    The Commission has carefully reviewed the comments received and 
agrees with the commenters that these restrictions can be eliminated 
and that certain other provisions can be modified. With regard to the 
proposed customer consent requirement and the limitation on proprietary 
interest, the Commission has adopted the suggestion of many commenters 
that, as detailed below, disclosure to the customer concerning 
allocation standards and procedures is an appropriate and less 
burdensome substitute that provides the same kind of customer 
protection. Based on its review of the comments, the Commission has 
modified and clarified the final rule as appropriate.

II. Amendments to Commission Regulation 1.35(a-1)

    The Commission is amending Regulation 1.35(a-1). Under Regulation 
1.35(a-1)(5), Orders eligible for post-execution allocation, specific 
customer account identifiers for accounts included in bunched orders 
need not be recorded at time of order placement or upon report of 
execution if certain requirements are met. The bunched order must be 
placed by an eligible account manager \11\ on behalf of eligible 
customer accounts and must be handled in accordance with contract 
market rules that have been submitted to the Commission pursuant to 
Section 5a(a)(12)(A) of the Act and Regulation 1.41. In the discussion 
below, the Commission sets forth each of the components of its 1998 
proposal, as summary of any pertinent comments received, and the manner 
in which the final rule addresses the issue.
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    \11\ The term ``account manager'' hereinafter is used to include 
investment advisers, commodity trading advisors (``CTA''), and other 
persons identified in paragraph 1.35(a-1)(5)(i) of the final 
regulation who would place orders eligible for post-execution 
allocation in accordance with the procedures set forth in the 
amendment.
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A. Eligible Orders

1. Proposed Regulation 1.35(a-1)(5)(i).
    The 1998 proposal required that bunched orders placed, executed, 
and allocated pursuant to the proposed regulation must be placed by an 
eligible account manager on behalf of consenting eligible customers as 
part of its management of a portfolio also containing instruments 
either exempt from regulation pursuant to the Commission's regulations 
or excluded from Commission regulation under the Act.
    The consent requirement was based upon the belief that the eligible 
account owners should have the opportunity to consent affirmatively to 
participate in the post-execution allocation procedure. Further, the 
account manager should be the appropriate party to obtain that consent 
and to advise the FCM allocating the order so that the FCM could assure 
that allocations ere made only to the eligible accounts.
    The portfolio requirement was based on the originally stated 
rationale for proposing that post-execution allocation be permitted, 
i.e., to permit account managers to provide equivalent treatment to 
customers' accounts traded pursuant to strategies involving activity in 
both futures markets and non-futures markets. Where trades were 
executed only on domestic futures exchanges, the Commission stated that 
the account manager should be able to achieve equivalent treatment of 
customers' accounts while complying with either the existing customer 
account identifier requirements \12\ or exchange average pricing rules. 
Nonetheless, the Commission requested comments concerning the placement 
of futures-only orders where the use of predetermined allocation 
formulas or average pricing would be insufficient to provide equivalent 
treatment to customers' accounts.
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    \12\ Regulation 1.35(a-1)(1) and (2)(i) or the predetermined 
allocation formula exceptions thereto as described in Appendix C to 
Part One of the Commission's regulations.
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2. Comments Received
    All commenters who addressed the issue of consent suggested that 
disclosure to the customer that orders would be allocated on a post-
execution basis, rather than written consent, would be appropriate.\13\ 
NFA and MFA

[[Page 45701]]

recommended that required disclosure should include specific customer 
protection information including, among other things, a description of 
any allocation methodology.\14\
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    \13\ NFA, ICI, and CBT. CME and NYMEX commented that the 
Commission should defer regulation of the relationship between the 
account manager and the account manager's customer to the account 
manager's primary regulator, but that, if the Commission does act in 
this area, it should require only disclosure. MFA commented that all 
customers, not just the most sophisticated, should be able to 
participate in bunched orders being allocated on a post-execution 
basis. Under these circumstances, disclosure would be adequate for 
the sophisticated customers but signed acknowledgements evidencing 
customer consent should be required from unsophisticated customers.
    \14\ These recommendations are discussed in detail below in 
paragraph 1.35(a-1)(5)(iii) of the final rule.
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    All commenters addressing the portfolio requirement suggested that 
it be eliminated and that futures-only orders be permitted to be 
allocated on a post-execution basis.\15\ Commenters represented that 
there are situations in which futures-only orders need to be allocated 
on a post-execution basis in order to attain fairness across accounts, 
thus satisfying the original rationale for the proposal. Included among 
the instances described by commenters where relief may be necessary 
were trading advisors who trade esoteric volatility spreads, who 
arbitrage, or who otherwise trade combinations of different futures and 
option contracts.\16\ MFA and NYCE commented that relief may be 
necessary with regard to orders for which the account manager seeks to 
average price where the trading strategies are such that trading 
decisions made intraday are dependent upon prior trades or allocations. 
MFA and NYMEX stated that relief would be necessary in the case of 
orders for multiple accounts at multiple FCMs that are placed on more 
than one futures exchange. MFA identified a need for relief for orders 
for which a partial fill received at one exchange must be rounded out 
by an order in a related instrument at another exchange. Finally, NFA 
and MFA stated that relief was necessary when large orders are placed 
through a series of smaller orders in order to disguise the size of the 
order or to alleviate the impact of one order upon market prices.\17\ 
Commenters also noted that average pricing is not a viable alternative 
in that it is not available at all exchanges and is not structured to 
handle partial fills.\18\ Similarly, NFA and NY Bar noted that the use 
of predetermined allocation instructions may not be practicable given 
the complex and dynamic trading programs used by large, sophisticated 
advisors.
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    \15\ NFA, MFA, CBT, NYMEX, CSCE, NYCE, and Goldman. NY Bar 
commented that futures-only orders placed on more than one futures 
exchange should be eligible for post-execution allocation.
    \16\ NFA, CBT, NYMEX, and CSCE.
    \17\ Additionally, Goldman commented that account managers 
executing futures-only orders have the same need to respond rapidly 
to market movements and to use trading models and systems that are 
complex and may involve numerous adjustments throughout the course 
of a single trading day. As a result, it may often be necessary for 
an account manager, particularly in fast moving markets, to be able 
to execute orders instantly and to allocate the fills after 
completion of the transaction.
    \18\ NFA, NY Bar, NYMEX, CSCE, NYCE, and Goldman.
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3. Final Regulation 1.35(a-1)(5)
    After consideration of the comments, the Commission has concluded 
that it would be appropriate to delete the requirement for eligible 
account owners to consent to orders being allocated on a post-execution 
basis. First, the customers for whom orders could be placed and 
allocated pursuant to these procedures have previously been identified 
by the Commission as sufficiently sophisticated to monitor the results 
of post-execution allocations in their accounts.\19\ Second, based in 
large part upon comments submitted by NFA and MFA, the Commission has 
included in the final regulation a requirement that the account manager 
disclose detailed information to its eligible customers. This 
information, discussed in detail in final rule paragraph 1.35(a-
1)(5)(iii) below, is designed to apprise the account owner of 
allocation methodologies, fairness standards, availability of data for 
comparing returns on investment, and any proprietary accounts that may 
be included in the bunched order. These disclosures serve as an 
appropriate substitute for formal customer consent.
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    \19\ 63 FR 695, 700. The eligible customers are identified and 
discussed below in paragraph 1.35(a-1)(5)(ii) of the final rule.
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    The Commission has also determined that it would be appropriate to 
delete the portfolio requirement. As previously stated, the overriding 
rationale for allowing post-execution allocation is to permit 
equivalent treatment of customers' accounts. The Commission believes 
that the commenters have sufficiently demonstrated that there are 
situations in which account managers placing futures-only bunched 
orders for eligible customers may need the relief afforded by post-
execution allocation in order to achieve equivalent treatment of 
costumers' accounts. Further, the commenters have sufficiently 
demonstrated that there are also situations in which the use of either 
predetermined allocation instructions or average pricing may not be 
adequate to assure equitable treatment of customer accounts included in 
a bunched order.

B. Eligible Account Managers

1. Proposed Regulation 1.35(a-1)(5)(ii)
    The 1998 proposal required that the account manager placing and/or 
directing the allocation of an eligible order must be one of the 
following which has been granted investment discretion with regard to 
eligible customer accounts: a CTA registered with the Commission 
pursuant to the Act; an investment adviser registered with the 
Securities and Exchange Commission (``SEC''), pursuant to the 
Investment Advisers Act of 1940; or a bank, insurance company, trust 
company, or savings and loan association subject to federal or state 
regulation.\20\
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    \20\ On the basis of comments to the 1993 proposal, the 1998 
proposal included CTAs as eligible account managers. Otherwise, the 
group of entities proposed to be eligible account managers was 
identical to that originally found in the 1993 proposal.
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    The Commission stated that these entities might be able to use the 
relief afforded by the eligible order procedures to achieve equivalent 
results for eligible customer accounts being traded pursuant to 
strategies involving trading activity in more that one market. Eligible 
account managers would be able to allocate futures and option trades in 
the same manner as they allocated trades on securities exchanges and 
over-the-counter markets.\21\ Additionally, these entities' fiduciary 
activities were subject to oversight by various state or federal 
regulatory agencies.
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    \21\ See, e.g., Interpretation 88-3 of New York Stock Exchange 
(``NYSE'') Rule 410(a)(3): ``Member organizations may accept block 
orders and permit investment advisors to make allocations on such 
orders to customers and remain in compliance with Rule 410(a)(3) 
provided that the organizations receive specific account 
designations or customer names by the end of the business day.''
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2. Comments Received
    Numerous commenters stated that foreign advisers play a significant 
role in U.S. financial markets \22\ and suggested that the list of 
eligible account managers should be expanded to include foreign 
advisers.\23\ MFA suggested including investment advisers exempt from 
SEC registration under Section 203(b)(3) of the Investment Advisers Act 
of 1940. Finally, CBT proposed that exchanges should be

[[Page 45702]]

afforded the flexibility to expand the relief, on a case-by-case basis, 
to other account mangers who are adequately regulated and subject to 
fiduciary liability.
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    \22\ NFA, CBT, CSCE, NYCE, and Goldman.
    \23\ NFA, MFA, NYCE, Man and CSCE (foreign advisors registered 
with, or exempt from, Commission registration, regulated in the 
advisor's home jurisdiction, and providing advice to non-U.S. 
persons), CBT (registered with the Commission), and Goldman 
(operating pursuant to Regulation 30.10 exemptions, located in 
countries that have received Regulation 30.10 exemptions, or 
otherwise).
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3. Final Regulation 1.35(a-1)(5)(i)
    After consideration of the comments, the Commission believes that 
it is appropriate to expand the list of eligible account managers to 
include foreign advisers who provide advice solely to foreign 
persons.\24\ However, the Commission remains concerned that foreign 
advisers are not subject to U.S. regulation and could use the ability 
to allocate orders among customers after execution as a vehicle to 
engage in fraud, money laundering or other abusive financial schemes. 
Thus, the Commission has determined to include only those foreign 
advisers who are subject to regulation by a foreign regulator or self-
regulatory organization (``SRO'') that either (1) operates under a 
regulatory framework that has been found by the Commission to be 
comparable to that in the United States and has been issued a 
Commission Order under Regulation 30.10 or (2) has entered into a 
Memorandum of Understanding (``MOU'') or other arrangement for 
cooperative enforcement and information sharing with the Commission 
(hereafter referred to as a ``foreign authority'').
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    \24\ A foreign advisor who places orders on U.S. futures 
exchanges for U.S. persons would be required to register as a CTA 
and, thus, would be included as an eligible account manager when 
placing bunched orders for eligible customers.
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    In addition, as discussed below in final rule paragraph 1.35(a-
1)(5)(iv), the Commission is adding a certification requirement that 
must be met in order for a foreign adviser to be an eligible account 
manager. The foreign authority must certify that (1) the foreign 
adviser's activities are subject to regulation by that foreign 
authority and (2) the foreign authority will provide, upon request of 
the Commission or Department of Justice, information that relates to 
the foreign adviser's compliance with this rule. The Commission 
believes that restricting foreign advisers who may be eligible account 
managers in this manner, in combination with the certification 
requirement, will help facilitate the detection and deterrence of 
fraud, money laundering or other abusive financial schemes.
    The Commission is not including as eligible account managers 
investment advisers exempt from SEC registration under Section 
203(b)(3) of the Investment Advisers Act of 1940 or CTAs exempt from 
Commission registration under Section 4m(1) of the Act. These entities 
are not examined in the ordinary course of audits conducted by the SEC 
or NFA, respectively.

C. Eligible Customers

1. Proposed Regulation 1.35(a-1)(5)(iii)
    (a). 1.35(a-1)(5)(iii)(A)--Types of Customers. The 1998 proposal 
provided that eligible orders could be placed on behalf of, and 
allocated to, accounts owned by an identified group of entities 
(``eligible customers'') which has consented in advance and in writing 
to the account manager that orders could be placed, executed, and 
allocated in accordance with the eligible order 
procedures.25 Except for the exclusion of sole 
proprietorships, natural persons, floor brokers, floor traders, and 
self-directed employee benefit plans, the group of eligible customers 
was substantially similar to those entities defined as ``eligible 
participants'' for purposes of Part 36--Exemption of section 4(c) 
Contract Market Transactions, of the Commission's 
regulations.26 Having previously considered this group of 
entities and determined that they are eligible to participate both in 
exempt transactions and in swaps, the Commission determined that they 
are sufficiently sophisticated to monitor the results of any post-
execution allocations in their accounts.
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    \25\ The issue of customer consent was discussed above. As 
noted, the Commission is eliminating the consent requirement, but 
including disclosure requirements to assure the customer is apprised 
of, among other things, allocation methodology and fairness 
standards.
    \26\ As the Commission stated in promulgating the final rules 
for Part 36, the list of ``eligible participants'' was modeled on 
the list of ``appropriate persons'' set forth in Section 4(c)(3)(A) 
through (J) of the Act and on the definition of ``eligible swap 
participant'' under Part 35 of the Commission's regulations. 60 FR 
51328 (October 2, 1995).
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    Accounts owned by sole proprietorships, floor brokers, floor 
traders, natural persons, and self-directed employee benefit plans were 
not included as eligible customers.
    (b). 1.35(a-1)(5)(iii)(B)--Proprietary Interest. The 1998 proposal 
provided that the following persons, or any combination thereof, could 
not have an interest of ten percent or greater in any account that 
received any part of an eligible order:
    (i) the account manager,
    (ii) the futures commission merchant allocating the order;
    (iii) Any general partner, officer, director, or owner of ten 
percent or more of the equity interest in the account manager or the 
futures commission merchant allocating the order;
    (iv) Any employee, associated person, or limited partner of the 
account manager or the futures commission merchant allocating the order 
who affects or supervises the handling of the order;
    (v) Any business affiliate that, directly or indirectly, controls, 
is controlled by, or is under common control with, the account manager 
or the futures commission merchant allocating the order, or
    (vi) Any spouse, parent, sibling, or child of the foregoing person.
    The limitation to less than ten percent ownership interests in any 
account that received any part of an eligible order was intended to 
balance the potential for misallocation with the recognition that there 
are situations where proprietary accounts should be permitted in a 
bounded order. For example, the Commission was aware that proprietary 
accounts might properly be included with customer accounts in a bunched 
order where the account manager had ``seed'' money invested in an 
account or where the account manager invested in an account in order to 
attract other investors. In addition, a complete prohibition on any 
interest in an included account would exclude certain publicly owned 
organizations from becoming eligible customers and thus would result in 
unfair customer treatment.
2. Comments Received
    (a) 1.35(a-1)(5)(iii)(A)--Types of Customers. All commenters 
addressing eligible customers suggested that the list be expanded to 
include natural persons.27 CBT and CSCE commented that the 
list should be expanded to include floor brokers and traders. MFA 
suggested that all eligibility restrictions should be eliminated.
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    \27\ NYCE and Man. NFA, CME, CBT, NYMEX, and CSCE commented that 
natural person as defined in Parts 35 and 36 should be included. MFA 
stated that natural persons as defined in Part 35 and Regulation 4.7 
should be included. NY Bar commented that natural persons meeting 
the ``qualified eligible client'' criteria defined in Regulation 
4.7(b)(1)(ii)(B) should be included. Goldman commented that natural 
persons meeting the ``qualified eligible participant'' criteria 
defined in Regulation 4.7 should be included.
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    Several commenters also suggested that the Commission should not 
create yet another definition of ``sophisticated customer.''\28\ Thus, 
CME and CBT proposed that the list of eligible customers should be 
consistent with the list of ``eligible participants'' in Part 36; CME, 
CBT, and MFA proposed that it should be consistent with the list of 
``eligible swap participants'' in Part 35; and MFA proposed that it 
should be

[[Page 45703]]

consistent with ``qualified eligible client'' under Regulation 4.7.\29\
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    \28\ NFA, MFA, NY Bar, CME, NYMEX, and CSCE.
    \29\ NY Bar recommended that the Commission eliminate the fixed 
total asset requirement applied to commodity pools in order for the 
pools to meet the eligible customer criteria. The fixed asset level 
would not address situations where the pool initially met the 
requirement but subsequently fell to a lower asset level because of 
investor redemption or trading losses. In the alternative, NY Bar 
commented that the fixed asset level requirement should be applied 
only at the inception of trading.
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    (b) 1.35(a-1)(5)(iii)(B)--Propriety Interest. Most commenters 
believed the provision limiting proprietary interest to an interest of 
less than ten percent was overly restrictive and should be 
eliminated.\30\ NFA and MFA stated that many institutional customers 
desire that their account managers trade their own funds just like the 
customers' funds and may, according to MFA, require that the account 
manger have a significant proprietary interest. It was noted that 
applying a percentage test to determine eligibility to bunch and 
allocate orders could prove administratively burdensome.\31\ MFA and 
Goldman stated that the account manager could be subject to potential 
liability because his or her interest may fluctuate in size over time. 
ICI commented that it would be very difficult, and in some cases 
impossible, for an account manager to determine ownership interest and 
monitor compliance with the ten-percent limitation.\32\
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    \30\ NFA, MFA, NYCE, and Goldman, NY Bar commented that 
proprietary interest in excess of ten percent should be permitted so 
long as it is disclosed. CBT commented that the limitation should be 
clarified to state that an account would not be disqualified from 
eligibility if from time to time the ten-percent interest test were 
exceeded on a temporary or marginal basis. This would permit some 
limited flexibility as the limitation is applied to commodity pool 
operators or CTAs setting up new pools or liquidating old pools.
    \31\ NFA, MFA and Goldman.
    \32\ ICI recommended that interests in registered investment 
companies be excluded from the limitation or, in the alternative, 
that it be acceptable for the account manager to certify that it 
reasonably believes it is in compliance with the requirements of the 
regulation.
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    NFA commented that, if the allocation procedures satisfy certain 
core fairness principles, then it should not matter that proprietary 
accounts are included in the bunched order. MFA commented that, if the 
allocation methodology were fundamentally fair, non-preferential, and 
verifiable, it would be fair for all orders allocated by that 
methodology. MFA further stated that requiring the account manager to 
trade a proprietary account outside the bunched order would greatly 
diminish the effectiveness of the audit process and create complexity 
and opportunities for misallocations in monitoring, auditing and 
implementing the separate allocation procedures.\33\
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    \33\ MFA stated that requiring the limitation on proprietary 
interest could provide an opportunity for dishonest account managers 
to allocate fraudulently by altering the extent of their proprietary 
investment or otherwise changing the group of accounts that trade 
within, rather than outside, the bunched order. Goldman commented 
that preferential allocations to accounts in which the account 
manager has a proprietary interest would be more readily apparent 
and therefore more easily detected if the proprietary accounts were 
included in the bunched order.
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3. Final Regulation 1.35(a-1)(5)(ii)
    After consideration of the comments, the Commission has determined 
to modify the 1998 proposal's list of eligible customers to make it 
completely consistent with the Part 36 list of ``eligible 
participants.''\34\ Thus, the Commission is including as eligible 
customers natural persons, subject to the Part 36 total asset 
requirement, and floor brokers and traders.\35\ Likewise, the 
Commission is removing the 1998 proposal's restriction of self-directed 
corporate qualified pension, profit sharing, or stock bonus plans 
subject to Title 1 of ERISA for those plans that satisfy the ``eligible 
participant'' criteria of Part 36. The Commission believes that these 
entities are generally capable of understanding bunched order and post-
execution allocation procedures and risks. Further, in order to assist 
the eligible customers in this understanding, the Commission is 
requiring that the account manager disclose certain specific 
information to them. These disclosure requirements, discussed in detail 
in final rule paragraph 1.35(a-1)(5)(iii) below, are designed to 
apprise the account owner of allocation methodologies, fairness 
standards, availability of data for comparing returns on investment, 
and any proprietary accounts that may be included in the bunched order.
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    \34\ As previously noted, the Commission has considered this 
group of entities and determined that they are eligible to 
participate both in transaction under the Part 36 pilot program and 
in swaps and believes that they are sufficiently sophisticated to 
monitor the results of any post-execution allocations in their 
accounts.
    \35\ With regard to allocations to accounts owned by natural 
persons, the Commission believes that the various increased 
standards applicable to the manner in which account managers will be 
required to handle these accounts should mitigate the Commission's 
previously stated concerns.
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    The Commission has also determined that it is appropriate to 
eliminate the less than ten percent restriction on proprietary interest 
that would have been imposed upon the account manager, the FCM 
allocating the order, and other listed entities. The Commission is 
aware that the proposed limitation does not exist in other markets and 
agrees with the commenters that it would be administratively burdensome 
and difficult to manage and to enforce. Among other things, the account 
manager would have a difficult time determining the level of interest 
held by the total group of possible participants who would be subject 
to the limitation. That level of interest also would be subject to 
fluctuation, would require constant monitoring, and could result in 
inadvertent violations, e.g., when redemption in a fund occurred. The 
Commission also is aware that the eligible customers may prefer to 
invest with an account manager who has a significant proprietary 
interest in the trading activity, i.e., an account manager who puts his 
or her money at risk along with that of the customer. Finally, the 
Commission agrees with the commenters who stated that, if the 
allocation procedures are fair, they remain so even if the account 
manager has an interest in an included account.
    Therefore, the proposed interest limitations have been deleted. In 
addition, eligible account managers have been included in the list of 
eligible customers for whom orders may be placed and allocated on a 
post-execution basis. In order to assure that an eligible customer is 
aware that an account in which the account manager has an interest may 
be included with the customer's account in the bunched order, the 
Commission is requiring, as discussed below, that the account manager 
disclose his or her policies with regard to this issue.

D. Disclosure--Final Regulation 1.35(a-1)(5)(iii)

    As previously noted, the 1998 proposal required that the customer 
consent, in writing to the use of eligible order procedures, and the 
proposal placed a less than ten percent interest limitation on 
proprietary orders that could be included in the bunched order. Because 
the Commission has concluded that the customer protection intended to 
be provided by these proposed requirements can be provided as 
effectively through detailed disclosure, the Commission has determined 
to substitute disclosure requirements for the proposal's consent 
requirement and proprietary interest limitation.
    These disclosure requirements are based upon comments submitted by 
NFA and MFA both of which stated that strengthened customer protection 
could be attained by expanding disclosure requirements. Among other 
things, NFA proposed that the regulation should require that eligible 
account managers describe to their customers, in general

[[Page 45704]]

terms, their basic approach to allocating trades among participants in 
a particular trading program. NFA stated that the account manager 
should be required to represent to eligible customers that it regularly 
reviews each account to assure that the allocation methodology has been 
fair and equitable and that it will document the internal procedures 
and results of its regular analysis and maintain these procedures and 
results as firm records.\30\
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    \30\ As discussed below, NFA strongly supported the proposed 
requirement that each account manager make available data sufficient 
for customers to compare their results with those of other relevant 
customers.
---------------------------------------------------------------------------

    MFA commented that the account manager should be required to 
disclose to the customer the nature of its allocation methodology and 
the fairness standard required of the methodology, the ability of the 
customer to request confirmation regarding the operation of the 
methodology, and the extent to which the account manager includes 
accounts in which it has an interest in the bunched order. According to 
MFA, requiring that disclosure to the customer include this information 
would assure that the customer would be able to provide informed 
consent to participation in the bunched order and fair allocation 
procedures.
    The Commission has drawn upon these NFA and MFA comments to craft 
the disclosure requirements found in the final regulation and described 
below. The Commission believes that compliance with these requirements 
will assure that the customer is armed with adequate knowledge of the 
bunched order and post-execution allocation procedures as they apply to 
his or her account and thus will have an enhanced ability effectively 
to monitor account activity. Thus, these disclosure requirements are an 
appropriate substitute for the written customer consent requirement and 
less than ten-percent proprietary interest limitation.
    Before placing the initial order eligible for post-execution 
allocation, the account manager must disclose the following to each of 
its customers to be subject to post-execution allocation:
    (i) The general nature of the allocation methodology the account 
manager will use;
    (ii) The standard by which the account manager will judge the 
fairness of allocations;
    (iii) The ability of the customer to review summary or composite 
data sufficient for that customer to compare its results with those of 
other relevant customers;\37\ and
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    \37\ Of course, the account manager would be expected to 
disclose the customer's ability to compare its results with those of 
similarly traded accounts in which the account manager has an 
interest, if such accounts are included. In those circumstances, the 
accounts in which the account manager has an interest would be 
accounts ``of other relevant customers.''
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    (iv) Whether accounts in which the account manager may have any 
interest may be included with customer orders in orders eligible for 
post-execution allocation.

E. Account Certification

1. Proposed Regulation 1.35(a-1)(5)(iv)
    In 1998 proposal required that, before placing the initial eligible 
order, the account manager certify in writing to each FCM executing 
and/or allocating any part of the order that the account manager was 
aware of the eligible order provisions and would comply with those 
provisions. Further, the account manager was required to provide each 
FCM allocating the order with a list of eligible futures accounts.
    The certification requirement was designed to assure that the 
account manager, who has overall responsibility for compliance with the 
eligible order provisions, was cognizant of, and would comply with, the 
provisions. The certification requirement would need to be made only 
once to each applicable FCM, and not on an order-by-order basis.\38\ 
The extent of the account manager's compliance with these requirements 
would be determined during audits and on a for-cause basis.
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    \38\ Where the account manager places orders directly with a 
floor broker rather than an executing FCM, the certification would 
have to be filed only with each FCM allocating any part of an 
eligible order and not with the floor broker.
---------------------------------------------------------------------------

2. Comments Received
    Commenters addressing the certification issue generally made two 
suggestions. First, the certification should be made only to the 
clearing FCM;\39\ and second, the certification should remain in effect 
unless revoked.\40\ With regard to the requirement that the account 
manager provided a list of eligible futures accounts, ICI commented 
that, rather than requiring a cumulative list, the Commission should 
permit an account manager to provide the FCM with eligibility 
information on an account either when it is opened or once a 
determination is made that it is an eligible account for purposes of 
the regulation.\41\
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    \39\ NFA, NYMEX, and Goldman, MFA suggested that the 
certification be made either to the clearing FCM or to the NFA. NFA 
also commented that the term ``represent'' should be used in place 
of ``certify.''
    \40\ NFA, CBT, and NYMEX.
    \41\ Man commented that the failure of an account manager to 
inform the FCM of any deviations or changes to the list of eligible 
accounts, as well as the potentially large number of accounts which 
may be on the list, could result in potential errors and delays in 
trade processing. The responsibility for fair, non-preferential 
allocation of orders among accounts is that of the account manager 
and not the FCM. Obviously, whether or not a list was provided to 
the FCM, an FCM has an ongoing obligation to inquire if there are 
appearances of preferential allocations. Thus, Man proposed that the 
requirement to provide a list of eligible futures accounts to the 
FCM not be required since it serves no meaningful purpose.
---------------------------------------------------------------------------

3. Final Regulation 1.35(a-1)(5)(iv)
    After consideration of the comments received, the Commission has 
determined that the account manager certification need be provided only 
to the FCM clearing any part of an order eligible for post-execution 
allocation to the ultimate customers. Further, this certification, once 
made, will continue in effect until the account manager revokes it or 
the FCM is otherwise notified of a change.
    With regard to the identification of the eligible customer 
accounts, the Commission agrees that a list of the accounts need not be 
required. Rather, the Commission has determined to require only that 
the account manager must identify these accounts to the FCM clearing 
any part of an order eligible for post-execution allocation. 
Identification may be accomplished by list; by notice at the opening of 
the account; by letter if the determination is made after the account 
is open; or by other, similar method. The Commission continues to 
believe that the requirement that the account manager identify the 
eligible customer accounts to the FCM should enable the FCM to insure 
that allocations are made only to those eligible customer accounts.\42\
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    \42\ The account manager must notify the clearing FCM when the 
account manager has notice that a previously identified eligible 
account is no longer eligible to be included in bunched orders 
allocated on a post-execution basis. However, if the account manager 
has a reasonable basis to believe that the account will regain its 
eligibility status within 10 business days, the account manager need 
not notify the FCM and may continue to treat that account as an 
eligible account. This timeframe is consistent with the maximum of 
10 business days which may be granted by the Commission, in its 
discretion, to allow an FCM or IB to achieve compliance with the 
Sec. 1.17 net capital requirements without having to transfer 
accounts and cease doing business. Thus, although a commodity pool 
would no longer be an eligible account if its total assets fell 
below the $5,000,000 threshold because of investor redemptions or 
trading losses, the account manager may continue to treat that 
commodity pool as an eligible customer account if the account 
manager has a reasonable basis to believe that the reduction in 
assets is temporary and that the commodity pool's total assets will 
be increased to the $5,000,000 within 10 business days.
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    Finally, in order to facilitate compliance with the requirements of 
this rule, as well as to facilitate the detection and deterrence of 
fraud, money laundering and other abusive

[[Page 45705]]

financial schemes, the Commission has determined that an additional 
certification requirement is appropriate. Foreign advisers must also 
provide to each FCM clearing any part of an order eligible for post-
execution allocation a written certification from a foreign authority 
that (1) the foreign adviser's activities are subject to regulation by 
that foreign authority and (2) the foreign authority will provide, upon 
request of the Commission or Department of Justice, information that 
relates to the foreign adviser's compliance with this rule.

F. Allocation

1. Proposed Regulation 1.35(a-1)(5)(v)
    The 1998 proposal required that the account manager and the 
clearing FCM allocate the order to eligible participating customer 
accounts prior to the end of the day the order is executed. Further, 
the proposal required that allocations be fair and nonpreferential, 
taking into account the effect on each relevant portfolio in the 
bunched order. These allocation requirements were designed to assure 
that allocations were made fairly, in a timely manner, and only to 
eligible customer accounts.
    As stated in the 1998 proposal, although the account manager has 
the responsibility for employing a system that results in fair, 
equitable, and non-preferential allocations, the FCM does assume some 
responsibility with regard to the fairness of the allocations.\43\ If 
the FCM were directed to allocate eligible orders to previously 
unidentified accounts or became aware of what appeared to be 
preferential allocations, the FCM would be required to make a 
reasonable inquiry and, if appropriate, to refer the matter to the 
appropriate regulatory authority.
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    \43\ As discussed herein, FCM responsibilities regarding the 
fairness of allocations are those of the clearing FCM.
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2. Comments Received
    Among the comments received that addressed the allocation 
requirements, NFA stated that it would be helpful to indicate that 
account managers should provide allocation information as soon as 
practicable after the entire transaction is executed but no later than 
the end of the day. Further, NFA suggested that the Commission clarify 
that ``end of the day'' might be defined by certain contract market or 
FCM operational timetables.\44\ MFA commented that order allocation 
should be required no later than the deadline for the submission of 
trade data established by the exchange on which the trade is made.
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    \44\ NFA encouraged the Commission to require that eligible 
account managers disclose to their customers that they will provide 
allocation information as soon as practicable after an entire 
transaction is executed, but no later than as required by certain 
exchange or FCM operational timetables.
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    Two commenters expressed concerns regarding allocation 
responsibilities proposed to be imposed on the FCMs. NY Bar commented 
that the requirement that the FCM conduct reasonable inquiry and refer 
to regulatory authorities any situations in which an order allocation 
formula appears to be abandoned or significantly departed from poses an 
unreasonable burden upon the FCM. In a similar vein, CBT commented that 
it is unnecessary to require the FCMs to have responsibilities above 
and beyond those already placed on them to ensure fair and equitable 
treatment of their customers by Regulation 166.3, which requires that 
FCMs diligently supervise the handling of customer accounts.
    Finally, NFA suggested that among the representations that the 
eligible account manager should be required to make to his or her 
customers is that the allocation methodology will be: (1) Non-
preferential, so that no account or group of accounts receive 
consistently favorable or unfavorable treatment; (2) sufficiently 
objective and specific that the appropriate allocation for a given 
trade can be verified in an independent audit; and (3) consistently 
applied.
3. Final Regulation 1.35(a-1)(5)(v)
    After consideration of the comments received, the Commission has 
determined to modify the timeliness and fairness standards and to add 
as allocation requirements the NFA's proposed representations regarding 
the allocation methodology. The requirement that allocations must be 
made only to the accounts of eligible customers is being retained.
    With regard to the timeliness of the allocations, the Commission is 
revising the standard to require that allocations must be made as soon 
as practicable after the entire transaction is executed, but no later 
than the end of the day the order is executed.\45\ The Commission is 
aware of no reason to postpone the allocations until the end of the day 
in situations where the results of the entire transaction are already 
known and fairness to the included accounts can thus be attained 
without further delay. Although it is no longer separately stated in 
this paragraph, the Commission continues to believe that the definition 
of ``end of the day'' for purposes of post-execution allocation may be 
specified by exchange rule. That provision was removed as an allocation 
requirement because it was redundant. Paragraph 1.35(a-1)(5) of the 
final rule already provides that orders eligible for post-execution 
allocation must be handled in accordance with exchange rules submitted 
to the Commission pursuant to Section 5a(a)(12)(A) and Regulation 1.41.
---------------------------------------------------------------------------

    \45\ As used herein, the term ``entire transaction'' includes 
the bunched futures and/or option order(s) and all related 
transactions executed in all markets for the included accounts.
---------------------------------------------------------------------------

    The Commission has modified the basic fairness standard of the 
allocation requirements in two areas. First, the standard in the final 
rule requires that the allocations must be fair and equitable and that 
no account or group of accounts may receive consistently favorable or 
unfavorable treatment.\46\ The Commission is aware that the existence 
of preferential allocations is best determined over a period of time 
and not on the basis of individual allocations.\47\
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    \46\ This requirement is consistent with allocation 
responsibilities imposed upon banks. Banking regulators require that 
banks effecting securities transactions for customers establish 
written policies and procedures for the fair and equitable 
allocation of securities and prices to the accounts when orders are 
placed for the same security. See 12 C.F.R. Sec. 208.24(g)(2) (1998) 
(requiring such procedures for state member banks); 12 C.F.R. 
Sec. 12.7(a)(2) (1998) (requiring such procedures for national 
banks).
    \47\ The Commission is also aware that an account in which the 
account manager has an interest could, on a given day, even using 
random allocation methodology, receive better allocations than one 
or more of the included customer accounts. The Commission would not, 
absent evidence to the contrary, find that this allocation violated 
the fairness standard so long as the account manager could 
demonstrate that the results were consistent with the allocation 
methodology disclosed by the account manager and so long as the 
favorable allocation is not representative of a pattern of 
preferential allocation.
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    Second, since the requirement that there must be a portfolio 
containing instruments which are either exempt from regulation pursuant 
to the Commission's regulations or excluded from Commission regulation 
under the Act has been deleted, the fairness standard no longer refers 
to ``taking into the account the effect on each relevant portfolio in 
the bunched order.'' Nonetheless, even without a portfolio requirement, 
the Commission expects that audits determining the fairness of 
allocations among accounts will consider all instruments and all 
transactions relevant to the accounts being audited.
    With respect to the account manager's allocation methodology, the 
Commission has determined to include as an allocation requirement NFA's 
proposed required representations regarding that methodology. That is, 
the

[[Page 45706]]

allocation standard in the final rule will include a requirement that 
the account manager's allocation methodology must be (1) sufficiently 
objective and specific that the allocation for a given trade can be 
verified in an independent audit and (2) consistently applied.
    Finally, the requirement that allocations must be made only to the 
accounts of eligible customers and must be made in a fair and equitable 
manner remains as stated in the proposal. The account manager has the 
responsibility for employing a system that results in fair, equitable, 
and non-preferential allocations. The FCM generally has the 
responsibility for complying with instructions from the account 
manager. The FCM also has additional responsibilities with regard to 
the allocations. If the account manager were to direct the allocation 
of fills into an account that has not been identified as an eligible 
account or if the FCM becomes aware of what appear to be preferential 
allocations, the FCM is required to make a reasonable inquiry and, if 
appropriate, to refer the matter to the appropriate regulatory 
authority, i.e., the Commission, NFA, or the FCM's designated self 
regulatory organization (``DSRO''). In addition, the FCM must act 
consistently with its obligations under Regulation 166.3 to supervise 
diligently the handling of its customer accounts.

G. Recordkeeping

1. Proposed Regulation 1.35(a-1)(5)(vi)
    The 1998 proposal required that each eligible order and the account 
manager placing the order be identified on the order tickets at the 
time of placement. Each transaction resulting from an eligible order 
was required to be identified on contract market trade registers, other 
computerized trade practice surveillance records, and confirmation 
statements provided to eligible customer accounts. These requirements 
were designed to assure the existence of a complete audit trail from 
order placement through order allocation.
    The 1998 proposal required that each account manager must make 
available, upon request of a representative of the Commission or the 
United States Department of Justice, customer consent documents and 
records reflecting futures and option transactions, other transactions 
executed pursuant to the portfolio management strategy, and any other 
records that would identify the management strategy and relate to, or 
reflect upon, the fairness of the allocations. Finally, it required 
that each account manager must make available for review, upon request 
of an eligible customer, data sufficient for that customer to compare 
its results with those of other relevant customers, prepared so as not 
to disclose the identity of individual account holders. The description 
of the requirement in terms of data was intended to permit the use of 
established methods used by sophisticated institutional investors in 
securities to measure and to compare performance. The comparison data 
could be prepared without requiring the disclosure of the identity of 
individual account holders.
2. Comments Received
    With respect to the requirement that the eligible order and the 
account manager placing the order must be identified on the office and 
floor order tickets, NFA suggested that the account manager be 
identified by code or other appropriate identifier, and CBT questioned 
the necessity of designating the account manager on the original order 
tickets. MFA and CBT suggested that the rule should permit the use of a 
group identifier with respect to the group of accounts to be allocated 
in the bunched order.\48\ MFA and CBT were opposed to the requirement 
that eligible order transactions be identified on trade registers and 
other computerized trade practice surveillance records.\49\ Several 
commenters suggested that the requirement that trades be identified on 
confirmation statements provided to the customer accounts should be 
deleted.\50\ Most of those commenters stated that such a requirement 
was redundant and unnecessary once the customer has been informed that 
orders for his or her account would be placed and allocated pursuant to 
the eligible order procedures.
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    \48\ In its comment objecting to the proposal's requirement that 
an eligible order must be identified throughout the execution, 
clearing, and confirmation procedures, MFA stated that the account 
manager should be required to identify the orders as eligible orders 
at the time of entry and on its trade blotter and allocation sheets.
    \49\ MFA stated that the cost of requiring compliance would be 
large without achieving any identifiable separate regulatory 
objective. CBT stated that the requirement would result in excessive 
cost to the industry and that the benefit of this type of 
information is questionable.
    \50\ NFA, MFA, CBT, Goldman, and Man.
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    MFA addressed the requirement that the account manager make certain 
information available, upon request, to the Commission or the 
Department of Justice. MFA objected to the requirement that the account 
manager maintain records demonstrating the relationship between the 
futures and other transactions. It contended that the eligible order 
relief should be available without regard to whether there were any 
other transactions and that the records demonstrating any trading 
strategy could cause unnecessary disclosure of proprietary trading 
strategies and procedures. MFA further commented that the rule should 
be narrowed to require retention only of information essential to the 
determination of the appropriateness of the allocations made.
    Numerous commenters addressed the requirement that comparative data 
be made available to the customer so that he or she could compare 
results with those of other relevant customers. NYCE supported the 
requirement as stated.\51\ NFA supported it as modified to define the 
data required to be made available as ``performance'' data. ICI 
supported it as modified to define the data as ``aggregated'' or 
``composite'' information. MFA recommended that the rule not require 
disclosure of comparative account information of other customers, but 
rather disclosure of summary information for the accounts for which 
such orders are made. NY Bar and CME recommended that the requirement 
be deleted.\52\
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    \51\ NYCE further commented that the data should also be 
required to be made available to regulatory authorities.
    \52\ NY Bar recommended, as an alternative, requiring the 
availability of comparable trading data for audit by the NFA. CME 
commented that the account manager's primary regulator should impose 
such a requirement if it determines that such a requirement is 
necessary.
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3. Final Regulation 1.35(a-1)(5)(vi)
    The Commission has determined to make several revisions to the 
proposed recordkeeping requirements. In order to provide for a more 
complete audit trail and consistent with SEC recordkeeping requirements 
applicable to investment advisers, the Commission is adding a 
requirement that the account manager, prior to placing the order, 
create and timestamp a document reflecting the terms of the order and 
the expected allocation thereof (``order origination document'').\53\ 
Any subsequent decision

[[Page 45707]]

to alter the included accounts, proposed allocation, or other terms of 
the order would likewise be required to be documented and timestamped. 
The Commission is specifying the information that must be retained, not 
the type or format of the document on which such information must be 
recorded. For instance, if an order and its allocation methodology were 
generated based upon a computer program, a copy of the computer-timed 
output document might be adequate. If an order were to be allocated 
according to a standardized methodology described in a pre-existing 
document, the timestamped order origination document need only reflect 
the terms of the order and a reference to the allocation methodology in 
that document, or to the document, as appropriate. The basic 
requirement is that the order origination document, which must be 
retained pursuant to Regulation 1.31, must assist an auditor in tracing 
the allocations attributable to a specific transaction by documenting 
the origin of that transaction.\54\
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    \53\ Among the books and records to be maintained by investment 
advisers registered or required to be registered under section 204 
of the Investment Advisers Act of 1940 are the following:
    A memorandum of each order given by the investment adviser for 
the purchase or sale of any security, of any instruction received by 
the investment adviser from the client concerning the purchase, 
sale, receipt or delivery of a particular security, and or any 
modification or cancellation of any such order or instruction. Such 
memoranda shall show the terms and conditions of the order, 
instruction, modification or cancellation; shall identify the person 
connected with the investment adviser who recommended the 
transaction to the client and the person who placed such order; and 
shall show the account for which entered, the date of entry, and the 
bank, broker or dealer by or through whom executed where 
appropriate. Orders entered pursuant to the exercise of 
discretionary power shall be so designated. 17 C.F.R. Sec. 275.204-
2(a)(3) (1997).
    Registered investment companies are also required to maintain 
records. Section 31(a) of the Investment Company Act of 1940 and 
Rule 31a-1(b)(5) thereunder require that registered investment 
companies maintain a current record of each brokerage order for 
securities, whether executed or unexecuted, showing, among other 
things, the terms and conditions of the order, the time of order 
entry or cancellation and the time of receipt of report of 
execution. 17 C.F.R. Sec. 270.31a-1(b)(5) (1997). Rule 31a-1(b)(6) 
applies the Rule 31a-1(b)(5) recordkeeping requirements to all other 
portfolio purchases or sales, such as futures transactions. 17 
C.F.R. Sec. 270.31a-1(b)(6) (1997).
    With regard to permissible procedures for bunching orders and 
allocating trades in securities, including the preparation of 
allocation documentation prior to order placement, see SMC Capital, 
Inc. SEC no-action letter (available September 5, 1995) and Pretzel 
& Stouffer SEC no-action letter (available December 1, 1995). 
Finally, as previously noted, MFA commented that the account manager 
should be required to identify orders eligible for post-execution as 
such at the time of entry and on its trade blotter and allocation 
sheets. See n. 48.
    \54\ Of course, the account manager must create and retain a 
record reflecting the participation of all accounts in each order 
eligible for post-execution allocation, including the allocations.
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    With regard to the information required to be identified on the 
office and/or floor order tickets, the Commission agrees with the 
commenters that a group identifier or other code would be adequate, so 
long as the order is identified as an order eligible for post-
execution. Thus, the Commission has deleted the requirement that the 
account manager placing the order must be identified on the order 
tickets. However, in keeping with the Commission's intention to enhance 
the ability of an auditor to trace the allocations attributable to a 
specific transaction, the Commission is also requiring that the group 
identifier or other code on each order ticket relate back to the 
specific order origination document described above.\55\
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    \55\ If the account manager places multiple orders to satisfy 
the investment criteria documented on the order origination 
document, each of the order tickets must contain the group 
identifier or other code that relates back to that specific order 
origination document.
---------------------------------------------------------------------------

    The Commission is retaining the proposed requirement that each 
transaction executed based upon an order eligible for post-execution 
allocation be identified on contract market trade registers and other 
computerized trade practice surveillance records. The Commission 
continues to believe that this is an important enhancement to the audit 
trail in that it would permit an order to be tracked throughout its 
processing.\56\ However, the Commission agrees with the commenters that 
the proposed requirement that the transactions must also be identified 
on confirmation statements provided to eligible customer accounts is 
unnecessary. Once the eligible customers have been informed that orders 
for their accounts will be placed and allocated as orders eligible for 
post-execution allocation, the trades need not be identified separately 
on confirmation statements.
---------------------------------------------------------------------------

    \56\ Because of the potential for misallocation, each exchange 
should routinely monitor the placement, execution, and allocation of 
orders eligible for post-execution allocation as part of its trade 
practice surveillance program.
---------------------------------------------------------------------------

    The proposed requirement that records be made available, upon 
request, to the Commission and Department of Justice has been retained, 
but modified to comport with other revisions to the 1998 proposal. The 
reference to consent documents has been revised to refer to disclosure 
documents, and the reference to the portfolio management strategy has 
been deleted. The requirement that records be made available to a 
customer for that customer to compare its results with those of other 
relevant customers has also been retained, but modified. As suggested 
by commenters, the provision specifies ``summary'' or ``composite'' 
data. The Commission believes that this revision should allay concerns 
that the disclosure of comparative account information might lead to 
the identification of a particular customer.\57\
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    \57\ Additionally, as previously stated, the account manager 
would be required to disclose to a customer that customer's ability 
to review composite or summary data sufficient for that customer to 
compare its results with those of similarly traded customers, 
including similarly traded accounts in which the account manager has 
an interest. Thus, the specific amount and extent of information to 
be provided could be determined by agreement between the account 
manager and his or her customer.
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H. Contract Market Rule Enforcement Programs

1. Proposed Regulation 1.35(a-1)(5)(vii)
    The 1998 proposal required that, as part of its rule enforcement 
program, each contract market that adopted rules allowing the placement 
of eligible orders must adopt audit procedures to determine compliance 
with certain account certification, allocation, and recordkeeping 
requirements.
    This surveillance requirement, to be met by the exchange as part of 
its routine oversight of member firms, was deemed necessary to deter 
possible unlawful activity and to ensure that an adequate audit trail 
existed for eligible orders. Under the proposal, the contract market 
was required to adopt audit procedures to determine compliance with (1) 
the certification requirements; (2) the requirement that orders must be 
allocated to eligible accounts by the end of the day; and (3) the 
requirement that eligible orders must be identified on order tickets, 
trade registers, other surveillance records, and customer confirmation 
statements.
2. Comments Received
    CBT and CSCE commented adversely on the audit procedures proposed 
to be required by exchanges. CBT commented that the responsibility for 
the surveillance of account managers seems to be appropriately placed 
on the NFA rather than on the exchange on which the trades are 
transacted. Thus, CBT argued that it would be duplicative and unduly 
burdensome to require exchanges to conduct specific regulatory reviews 
of these types of accounts as part of the regulations. CSCE commented 
that many of the areas required to be reviewed pertained to back-office 
FCM activities, which would fall within the scope of the review 
conducted by the FCM's DSRO and which would not be part of each 
exchange's rule enforcement program. Thus, according to CSCE, the only 
areas that would be subject to audit under an exchange rule enforcement 
program would be the requirement that eligible order transactions be 
identified on floor orders, exchange trade registers and other trade 
practice surveillance records.
3. Final Regulation 1.35(a-1)(5)(vii)
    The Commission continues to believe that oversight of these areas 
should be required. However, in response to the comments, the 
Commission has

[[Page 45708]]

modified the responsibilities identified by the 1998 proposal as part 
of an exchange's rule enforcement program. Audit of the recordkeeping 
requirements pertaining to data on exchange computerized records and 
entry data required on order tickets will remain as a responsibility of 
an exchange's rule enforcement program.\58\ Audit of certain of the 
certification, allocation, and recordkeeping requirements that pertain 
to the FCM will be a responsibility of the DSRO of the member firm. 
Thus, during its audit of a member firm, the DSRO will be required to 
determine that (1) the account manager's certification document is on 
file; (2) eligible customer accounts are identified; (3) allocations 
are made to eligible customer accounts; and (4) allocations are made by 
the end of the day the order is executed. Routine audit of the 
requirements that pertain to the account manager, such as fairness and 
adequacy of disclosure, remains the responsibility of the regulatory 
entity required to perform oversight of the account manager. The NFA, 
for instance, has the responsibility to perform routine oversight over 
member CTAs. Of course, the Commission has the authority to determine 
compliance with all of the rule's requirements and to conduct 
investigations as appropriate.
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    \58\ The exchange, as part of its rule enforcement program, 
would be expected to examine the order tickets for the presence of 
identifiers that would (1) indicate that the order was eligible for 
post-execution allocation and (2) relate back to the order 
origination document. The exchange would not be required to 
determine the validity of the identifier that related back to the 
order origination document.
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III. Conclusion

    Subject to certain core regulatory protections, the Commission's 
final regulation permits certain regulated account managers to place 
orders for a defined group of eligible customers without providing 
specific customer account identifiers at the time of order placement or 
upon report of execution.\59\ The commission previously has identified 
the listed customers as eligible to enter Part 35 swap agreements or to 
execute Part 36 contract market transactions. The account managers 
would be required to allocate the order as soon as practicable after 
the entire transaction is executed, but no later than the end of the 
day.\60\ As discussed below, in addition to the customer safeguards 
being imposed, significant existing and new audit trail and 
recordkeeping requirements would remain applicable.\61\
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    \59\ The Commission appreciates the views of the law enforcement 
authorities that commented on the previous proposals and shared 
their desire that Commission-regulated futures and option markets 
not be used as a vehicle to commit serious financial crimes. It is 
with those concerns in mind that the Commission has crafted the 
protections incorporated into the final regulation. These 
protections include specific eligibility requirements for account 
managers and customers, as well as disclosure, allocation and 
recordkeeping provisions intended to document fair and non-
preferential treatment of customers. Coupled with the strong 
antifraud provisions of the Act and the Commission's rigorous 
supervision rule, these protections should insure that the proposed 
allocation procedure would not unduly threaten customer protection 
or market integrity. Rather, the rule should enable account managers 
acting in a fiduciary capacity to handle customer interest without 
undermining any legitimate customer or law enforcement interests.
    \60\As previously noted, end-of-day or post-execution allocation 
of bunched or block orders is permissible on foreign futures 
exchanges and in the cash and securities markets. The NYSE has 
permitted end-of-day allocation of securities block orders since 
October 1983. Interpretation 88-3 of NYSE Rule 410(a)(3).
    \61\ NFA commented that the Commission should adopt the rule for 
a one-year pilot program and then reevaluate its usage with an eye 
toward expanding its application to other types of customers and 
making other adjustments deemed appropriate based upon experience. 
The Commission is satisfied that, based upon its experience with 
this issue, a pilot program is not necessary. Of course, the 
Commission retains the right to amend this regulation if actual 
experience with the rule indicates that modification would be 
appropriate.
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    Under the regulation, the account manager must disclose to the 
customer that orders may be placed, executed, and allocated as orders 
eligible for post-execution allocation. The account manager also must 
disclose the general nature of the allocation methodology that will be 
used and the standard by which the account manager will judge the 
fairness of the allocations. Allocations must be fair and equitable, so 
that no account or group of accounts may receive consistently favorable 
or unfavorable treatment.\62\ The allocation methodology must be 
consistently applied and must be sufficiently objective and specific so 
that the appropriate allocation for a given trade can be verified in an 
independent audit.\63\
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    \62\ Where applicable, the employing firm of an account manager 
should have appropriate internal controls in place to address the 
added discretion that the account manager will be able to exercise 
pursuant to this regulation.
    \63\ Pursuant to Regulation 166.3, an account manager's 
employer, if registered with the Commission, has a duty diligently 
to supervise his or her activities. Regardless of registration 
status, a principal could be held liable for an account manager's 
wrongdoing under Section 2(a)(1)(A) of the Act.
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    The account manager would be required to maintain records that 
would, among other things, reflect futures and option transactions and 
that would relate to, or reflect upon, the fairness of the allocations. 
These records would be available, upon request, to the Commission or 
the Department of Justice. The account manager also would be required 
to provide the customer, upon request, with summary or composite data 
sufficient for that customer to compare results with those of other 
similarly traded customers. The account manager would be required to 
disclose to the customer that customer's ability to obtain and review 
the comparative data.
    The rule requires that an account manager disclose to customers 
whether accounts in which the account manager has any interest may be 
included with customer accounts in bunched orders eligible for post-
execution allocation. In addition, the recordkeeping requirements would 
deter and facilitate detection of misallocations, which may indirectly 
benefit the account manager.\64\ The regulation also requires that an 
exchange that permits the placement, execution, and allocation of 
orders eligible for post-execution allocation must adopt, as part of 
its rule enforcement program, audit procedures to determine compliance 
with relevant recordkeeping provisions. The exchange, or the DSRO of a 
member firm clearing orders eligible for post-execution allocation, 
must adopt audit procedures to determine compliance with relevant 
certification, allocation, and recordkeeping requirements.
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    \64\ As a matter of state law or federal securities, 
commodities, and banking law, eligible account managers would have 
fiduciary responsibility for their investment management activities. 
Account managers would be subject to Section 4b, the general 
antifraud provision of the Act. Account managers who are also acting 
as CTAs or commodity pool operators (``CPO''), irrespective of 
registration status, would also be subject to Section 4o. Account 
managers who place orders for option contracts would also be subject 
to Commission Regulations 32.9 and 33.10, that prohibit fraud in 
connection with commodity option transactions.
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    Under the regulation, the account manager must, prior to order 
placement, create and timestamp an order origination document 
reflecting the terms of the order and the expected allocation of fills 
received. Any subsequent change to the terms or allocation must 
likewise be documented and timestamped. These documents must be 
retained under the Commission's record retention regulation. The order 
must be identified as an order eligible for post-execution allocation 
by group identifier or other code at the time of placement on the floor 
order ticket and, if appropriate, on the office order ticket. The group 
identifier or other code on the order tickets must relate back to the 
order origination document. All trades resulting from the execution of 
an order must be identified on exchange trade

[[Page 45709]]

registers and computerized trade practice surveillance records.
    Those requirements, in conjunction with existing audit trail 
requirements, should enable the Commission, other regulatory agencies, 
and self-regulatory organizations to track any eligible order from time 
of placement to allocation of fills. At the time of placement, the 
order would be identified on the order origination document and on 
order tickets. These order tickets would be timestamped upon receipt of 
the order. The order executions would be identified on trading cards 
and/or order tickets and on exchange trade registers by, among other 
things, both time and price. The order tickets would be timestamped 
again to identify time of report of execution. The subsequent 
allocation of the fills would be maintained on FCM and exchange 
records. Thus, an auditor could determine, among other things, the size 
and time of initial order placement, the times and prices of 
executions, the identities of accounts to which the fills were 
allocated, and the prices and quantities of the fills allocated 
thereto.
    Based on the foregoing, the Commission believes that this rule 
strikes an appropriate balance between regulatory protection and 
regulatory relief.

IV. Other Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601 et seq., 
requires that agencies consider the impact of rules on small 
businesses. The Commission has previously determined that contract 
markets,\65\ FCMs,\66\ registered CPOs,\67\ and large traders \68\ are 
not ``small entities'' for purposes of the RFA. The Commission has 
previously determined to evaluate within the context of a particular 
rule proposal whether all or some CTAs should be considered ``small 
entities'' for purposes of the RFA and, if so, to analyze the economic 
impact on CTAs of any such rule at that time.\69\ CTAs who would place 
orders eligible for post-execution allocation pursuant to these 
procedures would do so for multiple clients and would be participating 
as investment managers for a sophisticated group of eligible customers. 
Accordingly, the Commission does not believe that CTAs should be 
considered ``small entities'' for purposes of this regulation. 
Similarly, the Commission does not believe that foreign advisers 
placing orders pursuant to these procedures on behalf of sophisticated 
foreign investors should be considered ``small entities'' for purposes 
of this regulation.
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    \65\ 47 FR 18618, 18619 (April 30, 1982).
    \66\ Id.
    \67\ Id. at 18620.
    \68\ Id.
    \69\ Id.
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    Therefore, the Chairperson, on behalf of the Commission, hereby 
certifies, pursuant to 5 U.S.C. 605(b), that the action taken herein 
will not have a significant economic impact on a substantial number of 
small entities.
    Regulation 1.35(a-would provide relief from individual account 
identification requirements, thereby providing those small entities who 
qualify and elect to use the relief with a less burdensome method for 
satisfying Commission Regulation 1.35 requirements.\70\
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    \70\ The Commission received no comments addressing its 
conclusions with regard to the RFA.
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B. Paperwork Reduction Act

    When publishing final rules, the Paperwork Reduction Act of 1995 
(Pub. L. 104-13 (May 13, 1995)) imposes certain requirements on federal 
agencies (including the Commission) in connection with their conducting 
or sponsoring any collection of information as defined by the Paperwork 
Reduction Act. In compliance with the Act, this final rule informs the 
public of:

    (1) The reasons the information is planned to be and/or has been 
collected; (2) the way such information is planned to be and/or has 
been used to further the proper performance of the functions of the 
agency; (3) an estimate, to the extent practicable, of the average 
burden of the collection (together with a request that the public 
direct to the agency any comments concerning the accuracy of this 
burden estimate and any suggestions for reducing this burden); (4) 
whether responses to the collection of information are voluntary, 
required to obtain or retain a benefit, or mandatory; (5) the nature 
and extent of confidentiality to be provided, if any; and (6) the 
fact that an agency may not conduct or sponsor, and a person is not 
required to respond to, a collection of information unless it 
displays a currently valid OMB control number.

    The Commission has previously submitted this rule in proposed form 
and its associated information collection requirements to the Office of 
Management and Budget. The Office of Management and Budget approved the 
collection of information associated with this rule on March 14, 1998, 
and assigned OMB control number 3038-0022 to the rule. The burden 
associated with this entire collection, including this final rule, is 
as follows:

Average burden hours per response--3609.26
Number of Respondents--15,691.00
Frequency of Response--On Occasion

    The burden associated with this specific proposed rule is as 
follows:

Average burden hours per response--0.5
Number of Respondents--400.00
Frequency of Response--On Occasion

    Persons wishing to comment on the information required by this 
final rule should contact the Desk Officer, CFTC, Office of Management 
and Budget, Room 10202, NEOB, Washington, DC 20503, (202) 395-7340. 
Copies of the information collection submission to OMB are available 
from the CFTC Clearance Officer, 1155 21st Street, NW, Washington, DC 
20581, and (202) 418-5160.

List of Subjects in 17 CFR Part 1

    Brokers, Commodity futures, Commodity options, Commodity trading 
advisors, Commodity pools, Consumer protection, Contract markets, 
Customers, Designated self-regulatory organizations, Futures commission 
merchants, Members of contract markets, Noncompetitive trading, 
Reporting and recordkeeping requirements, Rule enforcement programs.
    In consideration of the foregoing, and pursuant to the authority 
contained in the Commodity Exchange Act and, in particular, Sections 5, 
5a, 5b, 6(a), 6b, 8a(7), 8a(9) and 8c, 7 U.S.C. 7, 7a, 7b, 8(a), 8b, 
12a(7), 12a(9), and 12c, the Commission hereby amends Part 1 of Chapter 
I of Title 17 of the Code of Federal Regulations as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

    1. The authority citation for Part 1 continues to read as follows:

    Authority: 7 U.S.C. 1a, 2, 2a, 4, 4a, 6, 6a, 6b, 6c, 6d, 6e, 6f, 
6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 
12c, 13a, 13a-1, 16, 16a, 19, 21, 23 and 24.

    2. Section 1.35 is amended by revising paragraphs (a-1)(1), (a-
1)(2)(i), and (a-1)(4) and by adding paragraph (a-1)(5) to read as 
follows:


Sec. 1.35  Records of cash commodity, futures, and option transactions.

* * * * *
    (a-1) * * *
    (1) Each futures commission merchant and each introducing broker 
receiving a customer's or option customer's order shall immediately 
upon receipt thereof prepare a written record of the order including 
the account identification, except as provided in paragraph (a-1)(5) of 
this section, and order number, and shall record thereon, by timestamp 
or

[[Page 45710]]

other timing device, the date and time, to the nearest minute, the 
order is received, and in addition, for option customers' orders, the 
time, to the nearest minute, the order is transmitted for execution.
    (2)(i) Each member of a contract market who on the floor of such 
contract market receives a customer's or option customer's order which 
is not in the form of a written record including the account 
identification, order number, and the date and time, to the nearest 
minute, the order was transmitted or received on the floor of such 
contract market, shall immediately upon receipt thereof prepare a 
written record of the order in nonerasable ink, including the account 
identification, except as provided in paragraph (a-1)(5) of this 
section or appendix C to this part, and order number and shall record 
thereon, by timestamp or other timing device, the date and time, to the 
nearest minute, the order is received.
* * * * *
    (4) Each member of a contract market reporting the execution from 
the floor of the contract market of a customer's or option customer's 
order or the order of another member of the contract market received in 
accordance with paragraphs (a-1)(2)(i) or (a-1)(2)(ii)(A) of this 
section, shall record on a written record of the order, including the 
account identification, except as provided in paragraph (a-1)(5) of 
this section, and order number, by timestamp or other timing device, 
the date and time to the nearest minute such report of execution is 
made. Each member of a contract market shall submit the written records 
of customer orders or orders from other contract market members to 
contract market personnel or to the clearing member responsible for the 
collection of orders prepared pursuant to this paragraph as required by 
contract market rules adopted in accordance with paragraph (j)(1) of 
this section. The execution price and other information reported on the 
order tickets must be written in nonerasable ink.
    (5) Orders eligible for post-execution allocation. Specific 
customer account identifiers for accounts included in bunched orders 
need not be recorded at time of order placement or upon report of 
execution if the requirements of this paragraph are met. The bunched 
order must be placed by an eligible account manager on behalf of 
eligible customer accounts and must be handled in accordance with 
contract market rules that have been submitted to the Commission 
pursuant to Section 5a(a)(12)(A) of the Act and Sec. 1.41.
    (i) Eligible account managers. The person placing and directing the 
allocation of an order eligible for post-execution allocation must be 
one of the following who has been granted investment discretion with 
regard to eligible customer accounts:
    (A) A commodity trading advisor registered with the Commission 
pursuant to the Act;
    (B) An investment adviser registered with the Securities and 
Exchange Commission pursuant to the Investment Advisers Act of 1940;
    (C) A bank, insurance company, trust company, or savings and loan 
association subject to federal or state regulation; or
    (D) A foreign adviser who provides advice solely to foreign persons 
and who is subject to regulation by a foreign regulator or self-
regulatory organization that has been granted an exemption pursuant to 
Sec. 30.10 of this chapter or has entered into a Memorandum of 
Understanding or other arrangement for cooperative enforcement and 
information sharing with the Commission (for the purposes of this 
section, referred to as a ``foreign authority''), provided that the 
certification required by paragraph (a-1)(5)(iv)(C) of this section is 
made.
    (ii) Eligible customers. The accounts for which orders eligible for 
post-execution allocation may be placed and to which fills may be 
allocated must be owned by the following entities:
    (A) A bank or trust company;
    (B) A savings and loan association or credit union;
    (C) An insurance company;
    (D) An investment company subject to regulation under the 
Investment Company Act of 1940 (15 U.S.C. 80a-1, et seq.) or a foreign 
investment company performing a similar role or function subject to 
foreign regulation, provided that the investment company has total 
assets exceeding $5,000,000;
    (E) A commodity pool formed and operated by a person subject to 
regulation under the Act or a foreign entity performing a similar role 
or function subject to foreign regulation, provided that the commodity 
pool or foreign entity has total assets exceeding $5,000,000;
    (F) A corporation, partnership, proprietorship, organization, 
trust, or other entity, provided that the entity has either a net worth 
exceeding $1,000,000 or total assets exceeding $10,000,000;
    (G) An employee benefit plan subject to the Employee Retirement 
Income Security Act of 1974 or a foreign entity performing a similar 
role or function subject to foreign regulation, with total assets 
exceeding $5,000,000 or whose investment decisions are made by a bank, 
trust company, insurance company, investment adviser subject to 
regulation under the Investment Advisers Act of 1940 (15 U.S.C. 80b-1, 
et seq.) or a commodity trading advisor subject to regulation under the 
Act;
    (H) Any government entity (including the United States, any state, 
or any foreign government) or political subdivision thereof, or any 
multinational or suparnational entity or any instrumentality, agency, 
or department of any of the foregoing;
    (I) A broker-dealer subject to regulation under the Securities 
Exchange Act of 1934 (15 U.S.C. 78a, et seq.) or a foreign person 
performing a similar role or function subject to foreign regulation, 
acting on its own behalf:
    (J) A futures commission merchant, floor broker, or floor trader 
subject to regulation under the Act or a foreign person performing a 
similar role or function subject to foreign regulation, acting on its 
own behalf;
    (K) An eligible account manager, as defined in paragraph (a-
1)(5)(i) of this section; or
    (L) Any natural person with total assets exceeding $10,000,000.
    (iii) Disclosure. Before placing the initial order eligible for 
post-execution allocation, the account manager must disclose the 
following to each of its customers to be subject to post-execution 
allocation:
    (A) The general nature of the allocation methodology the account 
manager will use;
    (B) The standard by which the account manager will judge the 
fairness of allocations;
    (C) The ability of the customer to review summary or composite data 
sufficient for that customer to compare its results with those of other 
relevant customers; and
    (D) Whether accounts in which the account manager may have any 
interest may be included with customer accounts in bunched orders 
eligible for post-execution allocation.
    (iv) Account certification. Before placing an order eligible for 
post-execution allocation, the account manager must provide the 
following to each futures commission merchant clearing any part of the 
order:
    (A) If not previously provided, certification, in writing, that the 
account manager is aware of, and will remain in compliance with, the 
requirements of this paragraph. This certification shall remain in 
effect until revoked by the account manager; and

[[Page 45711]]

    (B) If not previously identified, the identity of each eligible 
customer account to which fills will be allocated.
    (C) Foreign advisers must also provide a written certification from 
a foreign authority stating that the foreign adviser's activities are 
subject to regulation by that foreign authority and the foreign 
authority will provide, upon request of the Commission or Department of 
Justice, information that relates to the foreign adviser's compliance 
with the requirements of this paragraph.
    (v) Allocation. Orders eligible for post-execution allocation must 
be allocated in accordance with the following:
    (A) Allocations must be made only to the accounts of eligible 
customers.
    (B) Allocations must be made as soon as practicable after the 
entire transaction is executed, but no later than the end of the day 
the order is executed.
    (C) Allocations must be fair and equitable. No account or group of 
accounts may receive consistently favorable or unfavorable treatment.
    (D) The allocation methodology must be sufficiently objective and 
specific so that the appropriate allocation for a given trade can be 
verified in an independent audit.
    (E) The allocation methodology must be consistently applied.
    (vi) Recordkeeping. The following recordkeeping requirements apply 
to orders eligible for post-execution allocation:
    (A) Prior to order placement, each account manager must create and 
timestamp an order origination document reflecting the terms of the 
order and expected allocation thereof. Any subsequent determination to 
alter any terms or allocation of the order should likewise be 
documented.
    (B) Each order must be identified by group identifier or other code 
on the office and/or floor order tickets at the time of placement. The 
group identifier or other code on each order ticket must relate back to 
the specific order origination document required by paragraph (a-
1)(5)(vi)(A) of this section.
    (C) Each transaction must be identified as part of an order 
eligible for post-execution allocation on contract market trade 
registers and other computerized trade practice surveillance records.
    (D) Each account manager must make available, upon request of any 
representative of the Commission or the United States Department of 
Justice, the following records:
    (1) The disclosure documents required pursuant to paragraph (a-
1)(5)(iii) of this section; and
    (2) Records reflecting futures and option transactions and other 
transactions and any other records, including the order origination 
document, that would identify the management strategy or the allocation 
methodology or would relate to, or reflect upon, the fairness of the 
allocations.
    (E) Each account manager must make available for review, upon 
request of an eligible customer, summary or composite data sufficient 
for that customer to compare its results with those of other relevant 
customers. These summary data may be prepared so as not to disclose the 
identity of individual account holders.
    (vii) Self regulatory organization rule enforcement and audit 
procedures. As part of its rule enforcement program, each contract 
market that adopts rules that allow the placement of orders eligible 
for post-execution allocation must adopt audit procedures to determine 
compliance with the recordkeeping requirements identified in paragraph 
(a-1)(5)(vi) (B) and (C) of this section. Each contract market, or the 
designated self-regulatory organization of a member firm, must adopt 
audit procedures to determine compliance with the certification and 
allocation requirements identified in paragraphs (a-1)(5)(iv) and (a-
1)(5)(v) (A) and (B) of this section.
* * * * *
    Issued in Washington, DC on August 21, 1998 by the Commission.
Catherine D. Dixon,
Assistant Secretary of the Commission.
[FR Doc. 98-22933 Filed 8-26-98; 8:45 am]
BILLING CODE 6351-01-M